Stock-Picking by Mutual Funds: Evidence from Their Trades in Family-Controlled Firms

Abstract

Mutual funds on aggregate tilt their portfolios away from publicly traded family-controlled firms and they realize a lower return on these stocks compared to corporate insiders. In the cross-fund analysis, I find that active equity mutual funds that invest heavily in family firms (i.e., pro-FF funds) outperform other funds. Consistent with an informed fund hypothesis, pro-FF funds generate higher returns on family firms than other funds. In addition, pro-FF funds’ trading better predicts family firms’ stock returns and earnings announcement surprises than other funds’ trading. Pro-FF funds’ outperformance is greater before SOX in 2002 and when investing in opaque family firms. Finally, pro-FF funds acquire superior performance by investing in family firms geographically closer to the funds. Overall, the paper shows that family firms’ stock return overstates the actual return of mutual funds on these stocks and some mutual funds possess superior investing skills specific to family firms.

Keywords: Mutual funds; Investment Skills; Family Firms

JEL Classification: D11, D23, G11, G23, G32